Rational Expectations and The Firm’s Dividend Behavior
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Transcript of Rational Expectations and The Firm’s Dividend Behavior
COURSE TITLE: SEMINAR IN FINANCE COURSE CODE: MPH 622
Presentation on
Rational Expectations and The Firm’s Dividend
Behavior
By
Alice Nakamura and Masao Nakamura
University of Alberta
Published in: The Review of Economics and Statistics, 1985, pp. 606-15.
May 29, 2011
Why the study is conducted?
To study a rational expectation hypothesis of
management behavior. (addition of lagged earnings &
expected sign – positive).
The motivation is the econometric specifications of
Lintner’s Model where the change in dividends is
regressed on the current earnings and lagged dividends.
Research gap, specifically between Lintner (1956)
and Fama and Babiak (FB 1968).
What motivates researcher for the study?
The research gap in the finance literature specifically
between Lintner (1956) and Fama and Babiak (FB
1968).
Lintner’s Study:
Dividend = f(current earnings and lagged dividends)
FB’s Study:
The forecasting ability of the Lintner’s Model is
increased by adding the lagged earnings as a regressor.
Thus, the study is focus on the dividend behavior of the
firms may be described by an extension of Lintner’s
model.
What is the research gap?
The econometric model of the study is designed
based on the variables specified in Lintner’s Model and
FB’s work.
The model is the extension of Linter’s specification,
and
An important empirical difference between the
rational model and FB model is that the expected sign
of the coefficient of the lagged earnings variable is
negative in the rational model while in the FB model it
is positive.
The theoretical framework of the study.
The study is based on panel data for U.S. (1964-81=18
years) and Japanese (1961-80=20 years) firms.
The study is the extension of Lintner’s model &
additional explanatory variable is based on the FB’s
study, and the R-squared comparison is made between
Linter’s & Rational model.
What methodology is used for the study?
The comparison between in-sample and out-of-
sample time periods are also designed for the study
through simulation technique.
The country-wise data are classified in to two groups
i.e. pooling & endogeneity (r - independent variable
with error term) and split the data under in-sample and
out-of-sample into subgroup 1 (industry-country group
that experienced increases in EPS for 60% or more) &
subgroup 2 (remaining firms) to confirm the results.
The Lintner’s Model: ...(1)
Where,
=changes in dividends
Dt = Dividends paid out in year t
= Target dividend payout
c = Speed of adjustment to the difference between the target dividend payout and last
year’s payout
a0 = Constant
ut = error term
and,
The its extension: …. (2)
……………………………………… . (3)Where,
= the permanent earnings of the firm as perceived by the management or,
The econometric models specification:
ttt uDDcaD )( 1
*
0
D
*D
ttt uDrycaD )( 10
t
pt ryD*
t
py )( xMVRy m
t
p
………………………. (4)
Where,
δ is a drift term which represent firm’s expected growth
………... (5)
Where,
= Additional earnings in all future periods, Et = Condt. Expectations operator
Finally, to implement the rational model, the
following econometric model is specified and compare
with Linter’s model
……. (6)
Here, some restrictions applied: the coefficient of y1 is +ve, while yt-1 is –ve, and
11 ttt yy
))1/((1 byyE t
p
t
pt
))1/(( b
tttt cDyyaD 11210
21
b)/( 21
Table 1 – Estimated coefficients for the Rational and Lintner
model for U.S. and Japanese firms in selected industriesRational
Model & t
Rational Model & t
+ - - - + - - -
Against the priori
sign
Findings:For both countries, the coefficients have as per the priori sign so that .21
For both models the constant terms numerically larger and statistically more significant for Japanese firms than for U.S. firms.
Against the priori
sign
The results support the Lintner’sarguments that constant term is non-negative that indicates gradual growth in dividend payments.
21 αα
Table 2- Predictive
comparisons of the
Rational and
Lintner models
The in-sample as
well as the out-of-
sample values for
R2 are higher for
the Rational model
than for the Lintner
model for 11 out of
12 industry groups
for both the U.S.
and Japan.
With this, the study
The major
conclusion is
Rational model
yields somewhat
better predictions
of the dividend
payouts of firms
Exception Exception
More specifically, under the pooling heading
there is clear evidence that Rational model
outperform whereas under the endogeneity
heading except 4 out of 11 industry groups, a
similar results emerges from the out-of-
sample subgroup.
The finding of the R2 comparison under the
Pooling and Endogeneity heading indicated
that Rational model outperforms the Lintner
model for both subgroups of the firms.
The study concluded that under the rational
expectations hypothesis for a firm’s management, an
econometric specification of the firm’s dividend
behavior results the inclusion of a lagged earnings
variable in the Lintner model and,
The study provided empirically testable sign and
magnitude restrictions on the estimated coefficients of
the resulting model of dividend behavior.
What concludes from the whole analysis?
StrengthThe detailed description of the methodology and procedures
Discussion of the basic assumptions of the OLS regression
model, and
Specified the additional explanatory variable in Lintner model,
and
Contribution to the literature
WeaknessConclusions are based only on the R2 comparison criteria.
(By adding one extra variable in the existing Lintner model, it
gives higher R2 because the addition of new explanatory variable
in the regression model always produce the higher coefficient of
determination!)
Critical appreciation of the study